Invest Like Warren Buffett

byBrad FerrisonJanuary 16, 2017

I got an email in response to my 2016 Lessons Learned post asking me to clarify about my comments near the end of the post about Warren Buffett and investing.

“…I’ve said countless times this year: Don’t invest like Warren Buffett. Invest like Warren Buffett. So many investors want to copy, emulate and imitate Warren Buffett because of his success yet so few investors take the time to study how he was successful. Don’t copy his portfolio expecting his results from the past 40 years. Study his past 40 years and expect the results over your next 40….”

What I really meant to say was exactly what I said. I’ll simplify it a little though.

My belief is that there is more value in studying why Buffett made the decisions he did, at the time he did and how his successive decisions compounded the success of his earliest investments.

Investing in the 2017 stocks Buffett is buying now is almost futile because his decisions are influenced by the success of each of his prior decisions. Aside from shareholders of Berkshire (like me) few investors are in a situation to benefit from what he does today compared to an investor who originally bought Berkshire shares in 1964 or later.

I think your time is better served modeling his approach in a new way that reflects the difference in how the markets have changed. You need to reinvent the approach to reflect the changes and challenges 2017 and years forward present.

Warren Buffett benefited from prudent investing decisions when markets were far less efficient then they are now. His opportunities were vastly different also. His cost of capital and access to capital as time went on improved and the biggest benefit to his success was time, opportunity, good decisions and compounding returns. He made a number of big bets that paid off handsomely and he had the rare ability to allocate capital among a number of successful businesses owned within Berkshire. To assume that any of us can replicate that same success is delusional. In order to achieve the same market returns any one of us would need to act differently in an entirely different set of circumstances.

So if you really want to Invest like Warren Buffett you have to understand his approach, his education and how he thought back in 1954 when he started working for Benjamin Graham. You need to study his thought processes and realize your own limitations. You will not have the same opportunities he had; we may all only have a fraction of them.

So where does that leave us? Where do we start?

We start by getting into Buffett’s mindset and approach in 1954. Next is listing the reasons for Buffett’s successes and failures (yes he did have some of these) and looking to apply that in today’s market conditions.

When Buffett talks about an investment in an ETF of the S&P500 we should all pay close attention and listen. He understands the limitations in today’s markets that would prevent someone from replicating his success from the past 50 years. There is simply too much information, too quickly and too much competition for a single person to outcompete others for the opportunities Buffett was able to take advantage of. This is why indexing makes so much sense to him. It’s cheap, simple and long-term it will continue to beat most (if not all) approaches.

If you don’t want to fully index then individual stock selection is the start, based on a set of criteria that you understand and can identify. My Value Rules are one example. You need to understand how allocating capital is far more important to the success of your portfolio then how a single stock performs. Stock selection becomes very important as does the price you pay for it. You need to be able to take proceeds from one position and move it to another with equal or better prospects and know how to identify which. You need to take calculated and intelligent actions when the market is acting irrationally, when great companies are cheap and then have the patience to hold them for a long period of time. You need to ensure that your emotions are kept in check and you minimize mistakes. You need to identify a sustainable competitive advantage as an actual one and not because a stock report or analyst says a company has one. And you need to understand how market efficiency has changed, how opportunities are more challenging to find and the true benefit index investing offers you over the long-term.

For 95% of investors I will recommend indexing for a two simple reasons:

First, its cheap – you’re not paying for professional services that eat away at returns. A 2% MER for an actively managed group of mutual funds returning equal to the market leaves you with 20% of your potential return removed by fees (versus an indexed portfolio) allowing your return to erode by 4.5-7.5% in the same period.

Second, it teaches you important lessons. The beauty of an indexed approach is it gives you the time to learn how to allocate capital, diversify and make prudent and timely purchases rather then trying to time the market. It’s disciplined and simple to execute. It gives you time to learn stock selection techniques if you choose to develop a stock portfolio instead of making mistakes as you go thus reducing your ability to compound.
You get to play in the sandbox with the big kids without needing to learn all the rules right away. You’re going to do as well as everyone else and likely better than most.

If I could go back to my first 5 years of investing and apply what I know now I would be close to retirement already. That was 20 years ago. I didn’t suffer major losses in those first 5 years, but my naivety and inexperience prevented me from maximizing my gains and the compounded returns of what I invested would be worth substantially more today. If I was advising a 15 year old today I would tell them to start with a couch potato portfolio, teach them what they needed over the next 5-10 years and if they wanted then allow them to invest in individual equities.

For the other 5% of investors I will recommend they develop a stock portfolio mixed with indexing.

In my own portfolio I do this for REITs (3.2%) and a large portion of my US equity exposure (7.5% in Vanguard ETF’s). My time is better spent in other areas of investing then analyzing individual real estate investment trusts or following 5-15 US dividend paying stocks as I have in the past. For my Canadian equity exposure I have little interest in participating in a number of sectors the TSX is heavily weighted towards. I would much rather select the best prospects, collect the full dividends and reinvest those proceeds back into the portfolio over the long-term. My portfolio represents a balanced portfolio of Canadian dividend paying stocks across most sectors, with a low beta (volatility) and high quality operations.